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Investing in Medical Devices: Interview with Venture Capitalist Dave Eichler of Psilos

June 9th, 2014 Shiv Gaglani Exclusive

Many of our readers either use medical devices on a daily basis or are inventing new ones. Those in the latter group likely already have seen the bleak developments in the med device space, such as the Affordable Care Act’s excise tax (2.3%) and the lowest amount of investing dollars in the space in nearly a decade. We had the opportunity to speak with Dave Eichler of the Psilos Group, a healthcare investment firm, about the current landscape and why he thinks it’s improving.

Shiv Gaglani, Medgadget: What trends in medical tech, and specifically med devices, most excite you and your colleagues?David Eichler

Dave Eichler: Given the regulatory and reimbursement trends during the last decade, Psilos has grown increasingly selective with respect to medical device investing as have many of our peers who invest in venture and growth capital.  Approximately 8 years ago, we began migrating toward a later stage medtech strategy when it became evident investors were not being adequately rewarded for the risk they were taking in early stage companies.  We have an expansion/growth capital strategy today, which for Psilos means post-FDA approval, revenue stage, and more recently, established reimbursement.

A trend we are continuing to see today and have been for almost a decade involves the opportunity to lead investment rounds in companies with development stage risks fully mitigated. These same companies also are compelling because we can invest in a C or D round deal at an A-round price. This is where we are looking hard.

Another trend that is dominant today is one that Psilos led early on given our fundamental investment strategy and that was the premise for our first fund in 1998. Psilos has always been focused on investments that have a demonstrable impact on lowering the cost of healthcare and improving outcomes while aligning incentives across payers, providers and patients. Other investors jumped on this investment bandwagon four or five years ago due the changing reimbursement landscape and the Affordable Care Act. Today, we believe this investment tenet – lowering cost and improving quality — has to be an integral part of any medtech strategy in order to build to any meaningful level of success in the current healthcare environment.

 

Medgadget: We’ve seen investments in the med device space plummet. Do you think there will be an improvement?

Eichler: Yes, I do believe investors will eventually come back into the medical device market. They recognize that medical technology still has a very important role to play in terms of helping to lower cost and improve quality that remains an absolute imperative for healthcare reform no matter what happens with the Affordable Care Act.But today, there is a lot of ambiguity around the regulatory and reimbursement pathways for medtech companies. This environment caused the decline in activity and a shift toward later stage medtech investing among venture capitalists.  While some smaller funds and angels are prepared to take on that risk, the relative capital scarcity for early stage medtech companies has led to a funding chasm that makes it very tough to raise follow on rounds. Entrepreneurs need to figure out how to survive, but in the end, I do believe early stage investors will ultimately come back to bridge to gap.

 

Medgadget: Can you discuss any particular technologies you all are interested in?

Eichler: Yes, it’s in the imaging diagnostics space. One of the companies in this market we believe will be successful is Gamma Medica, given their cost-effective molecular imaging system for early detection of cancer in women with dense breasts. Molecular breast imaging is important not only because it is finding cancers that other techniques can’t in dense breasts, but also because it can significantly reduce the overall cost of breast cancer screening and diagnosis. This was recently validated in an economic study published by the actuarial firm Milliman, which showed that 38% of the total cost of breast screening episodes comes from follow on diagnostics and 18% of that is from biopsy, the vast majority of which are unnecessary.

I believe there is a lot of investment upside today due to the breast imaging market that, just in North America, involves more than 53 million mammography screening and 10.4 million diagnostic procedures annually.  These numbers will grow faster than the historical 6% compound annual growth rate (CAGR) because of an increase in the number of insured women, and mandated coverage at no cost to the patient for breast screening under the Affordable Care Act.

Gamma Medica’s molecular breast imaging system is called LumaGEM. Its technology uses fully solid-state digital gamma camera detectors as a functional imaging technique where lesions in the breast literally light up on the image as a ‘hot spot’ regardless of breast density.  The test is highly sensitive — equivalent to MRI actually, but at less than a third of the cost — and it can detect lesions as small as 3mm.  But it is also highly specific which means fewer false positives and therefore fewer unnecessary breast biopsies – around 85% of which come back negative.

What’s also helping this market and company become very successful is that the dense breast notification laws have been passed in 15 states so far which means there is finally growing awareness among women about the inadequacy of standard mammography screening for dense breast.  So a solid value proposition for payers, providers and patients all bodes well for imaging diagnostics companies like Gamma Medica.

 

Medgadget: How did you become interested in the medical device market?

Eichler: Medical device investing was a natural extension of our original investment strategy. Psilos is different from most healthcare investors because, since our founding, we have focused on investing in healthcare companies which have a direct impact on lowering the cost of healthcare while also improving quality and aligning economic incentives across the entire healthcare ecosystem.  Essentially we view new medical device investment opportunities through a health economics lens rather than a technology lens.  When I started out as a venture capitalist more than 15 years ago, few medtech entrepreneurs could articulate a value proposition about lowering cost, improving quality and aligning economic incentives.  Their presentations would generally cover the technology, clinical development and patent portfolio.  When they started talking more about how their device or technology actually improved cost and quality, that’s when we became interested.

 

Medgadget: You sit on the board of Gamma Medica. What drew you to the company?

Eichler: The imaging diagnostics space, and breast imaging market in particular, is large and has great upside. Gamma Medica has a highly sensitive, highly specific and cost-effective functional imaging technology that impressed us. We looked at numerous companies in this space and what we liked the most was the potential economic impact of this technology. Ultimately Psilos believes that Gamma Medica can significantly increase the effectiveness and reduce the overall cost of breast cancer screening.  More insured patients under the Affordable Care Act and growing awareness among women about the dense breast problem will increase the size of an already large market.  All of this makes for a good investment under our model.

We know that traditional breast screening misses way too many cancers.  Looking at a mammogram for the 40% of women with dense breast tissue is like trying to find a snowball in a snowstorm – everything appears white.  At the same time, these women are at greater risk for developing cancer because of their breast density. Gamma Medica has developed a functional imaging technique that delivers the very best combination of both sensitivity and specificity for early detection of cancer in dense breast women. Gamma Medica’s technology is an all-around-win for the provider, patient and payers, which we believe are all necessary ingredients to building a successful business.

 

Medgadget: What changes have you seen in medical device investing as a whole, specifically related to valuations?

Eichler: There have been lots of changes and not necessarily good ones. A decade ago, regulatory approval for a device was a meaningful value inflection point for medtech companies and capital availability for these deals at that stage was plentiful.  Fast forward to 2014, and this market and valuation situation has totally changed.  Today investors are recognizing that the reimbursement pathway can be just as long, or even longer, than the development and regulatory phase.  Also today, the IPO market for venture-backed medical device companies is virtually non-existent.  Strategic acquirers usually don’t present themselves until meaningful revenue momentum is achieved – around $30-50 million annually.  So this means that after regulatory approval, there is still a very long road to success until an exit happens.  Companies often need another $30-50 million or more to get there. Tie this to my expectation that as a venture investor, I want every company I invest in to deliver 4-5x returns in 4-5 years. It means that even at a zero pre-money value, I need to be confident I can exit at a $150-250 million valuation in 5 years after commercial launch. It’s tough to do.  Liquidity events for medical device companies in excess of that range are the exception, not the rule — and deals at early revenue stage are now being valued accordingly. Investors still have enthusiasm for some medtech companies with truly transformational technologies that address a very large market.  But mostly I’m seeing companies that would have been valued at $50 million pre-money 8 or 9 years ago now getting valued at less than half that today – if they can raise money at all.

divider

Link: Psilos Group Managers…

Shiv Gaglani

Shiv Gaglani is an MD/MBA candidate at the Johns Hopkins School of Medicine and Harvard Business School. In addition to curating the Smartphone Physical (www.smartphonephysical.org), he also contributes regularly to CardioSource World News and Emergency Physicians Monthly. He is interested in developing scalable, tech-based solutions for medicine and education; to this end he is the co-founder of the medical education tech start-up, Osmosis (www.osmosis.org).  More about Shiv: http://about.me/sgaglani

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